Bankruptcy Law & Unclean Hands: Do Two Wrongs Make a Right to Discharge a Debt?

Although a Consumer Chapter 7 Bankruptcy is intended to provide a “fresh start” for debtors, not all debts are dischargeable in bankruptcy.  In the matter of Northbay Wellness Group, Inc. v. Beyries, 2015 U.S. App. LEXIS 9397 (9th Cir. Cal. June 5, 2015), the Debtor Beyries stole money from Northbay who was a creditor in the bankruptcy case.  It seems obvious that debtors who steal money cannot discharge the “debt” owed to the victim of their theft in a bankruptcy proceeding.

Under the provisions of 11 U.S.C. § 523 (a) of the Bankruptcy Code:

A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt

(2) for money . . . to the extent obtained by –

(A) false pretenses, a false representation, or actual fraud

(4) for fraud or defalcation while acting in a fiduciary capacity…

(6) for willful and malicious injury by the debtor to another entity or to the property of another entity.

To take a well known recent example, if Bernie Madoff had declared a personal bankruptcy, he would not be able to discharge – release his legal obligation to repay – the zillions he stole from the owners of the New York Mets – amongst others.  Under §523(a), the debt would be deemed “non-dischargeable”.

However, in the Northbay case, the Ninth Circuit Court of Appeals was faced with the decisions of both a Bankruptcy Court and the Federal District Court that permitted Beyries to discharge the debt owed to Northbay which resulted from a theft.  So what was different about the money that Beyries stole from Northbay?   What the case was all about was the doctrine of “unclean hands”.

Litigants go to a court and plead; that is, they ask a court to do or not do something.  But what if someone – who has not acted honestly themselves – goes to a court and pleads that someone with whom they did business had cheated them?  For example, what if someone who was in the business of selling “medical marijuana”, was cheated by its lawyer?

In this case, Beyries was an attorney representing Northbay, a medical marijuana dispensary, and stole $25,000 from his client.  After Beyries filed for bankruptcy, Northbay sought a determination that the $25,000 was a non-dischargeable debt.  The bankruptcy court recognized that debts arising from theft are typically non-dischargeable, but it applied the doctrine of “unclean hands” to hold that Northbay’s illegal marijuana sales prevented Northbay from obtaining relief.

In order to decide the case, the Federal Appellate Court pulled out its imaginary scales of justice and weighed the conduct of Northbay and the conduct of Beyries – an analysis which Appellate Court said the Bankruptcy Court failed to perform:

“The bankruptcy court failed to conduct the required balancing, instead concluding solely from the fact that Northbay had engaged in wrongful activity that the doctrine of unclean hands applied. In so doing, the bankruptcy court made an error of law, and thus abused its discretion.”

What tipped the scale in favor of Northbay was that Beyries was a lawyer who stole money from a client.  This is the ultimate “no-no”.  For example,  in New Jersey, a lawyer who intentionally engages in the unauthorized use of a client’s funds is automatically disbarred.

“Had the bankruptcy court weighed the parties’ respective wrongdoing, it necessarily would have concluded that Beyries’ wrongdoing outweighed Northbay’s, both as to harm caused to each other and as to harm caused to the public.”

Based on its balancing of the equities, the Appellate Court reversed the decision of the Bankruptcy Court.

What can be learned from this case?  Did the Bankruptcy Court and the District Court need to send out their scales to be re-calibrated?  Not really.  This case is yet another example of a court decision being a product of the facts, the law, and the color of the lenses through which a court views the matter before it.  It is difficult to avoid the conclusion that the members of the Federal Appellate Court considered the sale of marijuana, although illegal, an innocuous activity in comparison to the ethical sin of an attorney stealing his client’s money.


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